|
|
|
|
The fiscal and monetary policies we have discussed thus far focus on the demand side of the economy. For example, the Keynesian aggregate expenditure framework deals with the components of aggregate demand to the exclusion of aggregate supply. As a result, the fiscal policy options forthcoming from this analysis are all demand-side policies. Similarly, the monetary policy options discussed thus far focus on the effects of the money supply on the consumption and investment components of aggregate demand. One of the downsides of using demand-side policies is their effect on the price level. For example, while the use of expansionist fiscal or monetary policy during a recession may stimulate aggregate demand and initiate an increase in aggregate demand, these policies also tend to be inflationary. Any time the economy is on the upward-sloping part of the AS curve, any increase in aggregate demand will cause an increase in prices. The promise of supply-side economics, on the other hand, is economic growth without inflation. Recall that if aggregate demand stays constant and aggregate supply increases, there will be downward pressure on prices along with an increase in output. Supporters of supply-side policies had their heyday during the early years of the Reagan Administration in the early 1980s. It is not difficult to see why these policies were so appealing at the time. During the mid-1970s, the economy experienced stagflation, the combination of high inflation and recession. High inflation rates and poor economic growth persisted throughout the 1970s and conventional fiscal and monetary policy measures were not effective in turning the economy around. Supply-side policies offered the hope of simultaneously lowering inflation and increasing economic growth. Many perceived it as being just what the doctor ordered! In 1981, the Economic Recovery Tax Act was signed into law. This act instituted large cuts in personal income taxes, aimed at increasing labor supply, cuts in corporate income taxes aimed at stimulating production, and cuts in capital gains and other taxes aimed at increasing capital investment.
|
